Debunking iPad Mini Rumors – Part II

In part one of this three part series, we took a look at all the individual component costs of the Amazon (NASDAQ:AMZN) Kindle Fire, the iPad 2 as well as the new iPad to make our own estimates of how much an iPad mini would cost Apple (NASDAQ:AAPL) to make, should it come out with such a tablet. We assumed that Apple would consider two versions of iPad mini – the low-end and the high-end – with the low-end mimicking the iPad 2 and the high-end the new iPad as many rumors in the market have it.

For the complete list of assumptions made regarding the low-end and the high-end specifications, take a look at our earlier post. See Debunking iPad Mini Rumors – Part I We arrived at a figure of about $194 and $273 for the respective iPad minis.

We see that in either case, pricing the iPad mini at anywhere close to $200-$250 will mean that Apple would have to go out of its comfort zone and take a margin hit, possibly even a loss. Note that we haven’t taken the operating expenses of marketing and R&D spend incurred to develop such a product into account yet. We therefore don’t see any reason why this would happen any time soon especially after two quarters of iPad sales post the Kindle Fire launch have emphatically dispelled concerns that the iPad might take a beating unless a smaller iPad is launched. (see Apple Doesn’t Need To Enter The Low-Cost Smaller Tablet Market)

Taking a margin hit would’ve made sense if the tablet market was mature and competition was eating into Apple’s market share (considering that Apple created the tablet market, initial market share loss is inevitable). But even in such a case, Apple has historically avoided playing the volume game (see smartphone market and the PC market), preferring instead to have a niche market following while cornering most of the industry profits. Moreover, Amazon makes its money from selling content such as e-books etc which is driven by the sale of hardware while Apple is a hardware company; so going into a price war with Amazon doesn’t make business sense and could spell doom for Apple.

Still, if Apple were to consider entering this market, the low-end iPad mini seems like a more reasonable bet. Although the sub-$200 cost of manufacturing the iPad mini is very competitive, it gives Apple only enough room to price its product closer to the levels of $299 and not at the oft-rumored $199 levels without taking a sharp hit to its margins. Keep in mind that iSuppli’s costs exclude the licensing and royalty expenses, which upon taking into consideration would cause gross margins to fall even more.

As for the high-end iPad mini, Apple will have to price it at about $399 levels to be able to command a premium of at least 30%, which has been the lower-end of its iDevice margins. However, with the iPad 2 already available at this price and the new iPad expected to fall to this price early next year, we don’t see Apple coming out with such a product unless it sees the Retina display or any other technological advancement compensating for the design limitations of the smaller size. Moreover, we feel the whole point of coming out with a smaller iPad is to appeal to the broader price sensitive population; so pricing it close to the levels of a bigger iPad seems to defeat that purpose. Further, the high-end iPad mini may even cannibalize on the sales of the bigger higher-margin iPads and is therefore a high-risk proposition for Apple.

With the launch of a high-end iPad mini seeming less likelier to happen than the low-end one, we will now consider the impact that the release of the latter might have on Apple’s stock. For our analysis, we will take into account two price points of entry for the iPad mini, $249 and $299. Over to the final part…

Great analysis - really appreciate the detail. Adding in part of Apple's strategy - deprecating down rev product support. Apple tends to drop support for older platforms. For this reason, they will not release a new smaller iPad with an older chip. As DRAM and SSD prices drop, we may see a smaller, cheaper iPad, with all the latest features and good margin for Apple.

Consider a subtle aspect of Apple's success - hand-me-downs. Adults who crave the latest Apple product, give their year-old product to a kid or other relative when they buy their own toy - a double feel-good. This may impact the market value of low-end products for Apple.

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